RBI policy: The MPC has done well to hold interest rates while being accommodative

The newly constituted Monetary Policy Committee (MPC) struck a refreshingly sanguine note in its policy statement on Friday, while deciding to keep the repo and reverse repo rates unchanged at 4 per cent and 3.35 per cent, respectively. The MPC’s optimism is based on the uptick in a number of high frequency indicators. It has rightly chosen to “look through the current inflation hump as transient” — caused by Covid-induced “supply disruptions and associated margins/mark-ups”. The MPC has retained its accommodative stance, signalling that it will do ‘all it takes’ to keep bond market yields in check. Inflation is expected to recede in Q3 and Q4, once the Covid scare peters out (with indications of the curve flattening) and spurs economic activity. In deciding to downplay inflation — despite its ruling above the upper bound of 6 per cent — “to address the more urgent need to revive growth and mitigate the impact of Covid-19”, the MPC has displayed remarkable clarity of purpose. It has avoided the standard monetary policy error of exaggerating the inflation threat in a time of de-growth — despite being an inflation-targeting monetary body.

In view of the prevailing negative real interest rates, the MPC cannot afford to cut repo rates any further without hurting savers. However, the MPC has indicated that the Centre’s borrowings will not deviate significantly from the weighted average cost of 5.8 per cent from the first half of this fiscal, while promising to open an OMO window for the States as well. A dip in inflation levels is expected to negate any impact of higher government borrowing on yields. Besides, there is no ‘crowding out’ effect in sight, given the feeble appetite among private investors. Household financial savings are unlikely to fall sharply. Hence, the MPC is confident that yields will be stable, perhaps through the rest of this fiscal — for which it has estimated a contraction in GDP of 9.5 per cent and a return to positive growth in Q4.

A fillip to the real estate sector through an adjustment in weightages; a higher permissible level of total retail exposure to one party (₹7.5 crore, against ₹5 crore so far); and an infusion of funds through term repos into private financial instruments should ensure that liquidity remains comfortable. Here, the MPC has done well not to be spooked by the threat of inflation. The question of whether the Centre will exceed its ₹12 lakh crore borrowing limit remains. In view of the revenue constraint and the prevailing level of inflation, the Centre should keep its powder dry for the next calendar year, while focussing on long-term asset creation.

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